“A good deal of our current economic
travails can be traced to the increasing valuation of
purportedly objective criteria, so denoted because they can
be expressed and manipulated in mathematical form by people
who may be skilled in such manipulation, but who lack
“concrete” knowledge or experience of the things being
traded. As Niall Ferguson has put it ‘those who the gods
want to destroy they first teach math’. The paradigm –
and the precursor of our current crisis – was the rise and
fall of Long Term Capital Management, founded by two of the
fathers of quantitative options financing, Myron Scholes and
Robert C Merton. Knowing a great deal about math, but not
very much history, they developed trading models that
radically underestimated the risk entailed in their
financial speculation, leading to a dramatic collapse of the
company in the summer of 1998. Attaching a number creates a
belief that the information is more solid than is actually
the case. This is what I mean by ‘pseudo-objectivity’.
In each case, it is a response to what (to recoin a phrase)
one might call alienation from the means of production, the
attempt to substitute abstract and quantitative knowledge
for concrete and qualitative knowledge.”

With
greater complexity and diversity, essentially the larger
financial institutions have become un-manageable, as those
in governance and senior managerial roles, lack the required
intimate specialist understanding of the risks involved.

Professor Muller continues –

“This message has
not yet taken hold among policy makers. There is much talk
about monetary policy and fiscal stimulus. But without
financial institutions that people have faith in, a fiscal
stimulus is unlikely to have much of a multiplier effect. It
is widely assumed that people will have faith in financial
institutions, if the Treasury injects capital in to them.
But the problem is not just that the financial institutions
are short on operating capital: it is that recent experience
seems to show that they are incapable of prudently managing
the capital they have. In short, economic actors believe
that other economic actors don’t know what they are doing.
Nor is the problem merely one of isolating ‘bad assets’
– it is of a system that creates bad assets because of
misaligned incentives and the fog created by opacity and
pseudo-objectivity.

Professor Muller then continues by
saying that confidence cannot be created out of thin air –
and that the current problems are likely to be exacerbated
as diversified firms are forced to amalgamate with other
diversified firms. Put simply – if they didn’t
understand what they were already managing – how can they
be expected to successfully manage something even larger and
more complex?

There is of course the example of the Bernie Madoff Ponzi Scheme where the
Securities and Exchange Commission failed to act, after
being repeatedly informed by Harry Markopolis, a specialist in the
field with a deep understanding of the issues. Essentially
– the SEC failed because it lacked people with sufficient
“concrete knowledge” of the financial instruments
involved. Markopolis is of the view that the SEC is “over
lawyered” with a serious lack of skilled people with the
required knowledge of the finance industry.

The “Dangers
of Superficial Knowledge” problem is not one confined to
just the finance sector – but is widespread both within
the public and private sectors.

The Australian Labour
Prime Minister Kevin Rudd for example could be described as
a “Specialist in Superficial Knowledge” with his rather
amusing “theories on economics – countered
effectively by the former Labour Government Treasurer of New
South Wales, Michael Costa - Rudd on a dangerous, ill-informed crusade |
The Australian.

It is generally widely understood that
the current Global Financial Crisis was triggered by the
“mortgage meltdown” in the State of California, where
housing had “bubbled” out to around 9 times household
earnings - with Texas, for example, through this era of
“easy money”, staying at 2.5 times earnings (Refer January 08 Dallas Fed Report and recent
Reuters recent report on Texas home building
market). For a “daily dose” of the latest horror
stories out of California (after all – “entertainment”
is major industry there – they gave up on “reality”
long ago) – check patrick net and Dr Housing Bubble.

California with a
population of 37 million and residential stock of some 13
million units median price peaked at in excess of $US500,000
and has slumped to near $US250,000. With the average price
being somewhat higher than the median – it is likely some
$US4 trillion of “bubble value” has been wiped out of
California housing so far – and possibly as much as $US8
trillion of “bubble value” across the 127 million
residential stock of the United States to date.

Within a recent Open Letter to Bernard Hickey, a senior
New Zealand business journalist and Managing Editor of
Interest Co NZ, I did a “rough assessment” of the
quantum of “global bubble value” (some $US100 – 200
trillion or 2 to 4 times Gross World Product) that is
currently in the process of evaporating.

Yet –
economists and allied professions and others appear to have
at best a shallow understanding of the significance and
consequences of the equity and debt leveraging and
deleveraging of specific housing markets globally. And most
importantly – that these unnecessary housing bubbles are
caused by regulatory failures at the local level, that must
be dealt with, to ensure they don’t get underway
again.

In reading media reports of “this weeks
stimulus” or market intervention – one would get the
impression that these are “cost free”. The question is
never asked whether they will likely work or not and what
the medium to long term consequences will be. Intervene in
haste and repent at leisure seems to be the favored approach
– as the “establishment” struggles (likely in vain) to
protect its political and commercial interests.

The
writers field is property development – a field I have
studied through 30 years of practical experience. I have
limited knowledge of other fields – unlike economists who
consider that they understand the wider economy. Within a
recent article Housing Bubbles And Market Sense I
attempt to sketch out how those with “superficial
knowledge” create massive problems – and further to this
– why there is an urgent need to get “simple performance
measures” (as recommended by the United Nations and World
Bank) inculcated in to Local Government culture as quickly
as possible. This is set out in “layman’s language”
within the rather lengthy paper "Getting performance urban planning in
place".

The reality is that those “schooled’ in a
subject – but not actually “educated” in it - with a
solid track record of practical experience – cannot be
expected to have the required skills to participate within
or regulate that particular field effectively. This is why -
with respect to urban housing markets and local government
generally – at least – there is a need for simple
performance measures. The Annual Demographia International
Housing Affordability Surveys (2009 5th Edition; 2008 4th Edition; 2007 3rd Edition; 2006 2nd Edition) should simply be seen
as a useful “first step”.

Indeed – for public
bureaucracies in particular (with the consultants that feed
off them) there is a strong incentive to “complicate and
confuse” – so that those they are accountable to are
“kept in the dark” – particularly with respect to the
issue of that particular institutions
“performance”.

Within the English speaking world –
the British public sector bureaucracies are the “most
gifted” at generating complicated and confusing
information of little relevance. I enjoy teasing British
colleagues that I expect them to generate more “housing
reports” this year than actual houses! As an example –
this year’s Demographia Survey could not obtain median
house price / median household income information for the
3rd Quarter 2008 for the United Kingdom – other than for
London and it surrounds. So it had to settle for the
regional level this year, with the latest information
available, being for the 1st Quarter of 2008. No doubt the
British bureaucrats are “overloaded” and “under
resourced” – as they repeat the history of the
“bureaucratic managed decline” of the 1970’s.

The
message is clear. Recovery cannot occur until the real
structural issues are dealt with effectively – across the
board. And that as individuals in our specialist fields –
with a little humility - we recognize just how limited our
wider knowledge
is.

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